Mock 5 Flashcards
A member is hired to write a research report on a company that is paid for by the company with a flat fee and fixed bonus if the firm’s shares become more widely held. The member is:
A)
not in violation of the Standards as long as the fact that the research is issuer-funded is disclosed.
B)
not in violation of the Standards as long as both the source of the funding and the nature of the compensation is disclosed.
C)
in violation of the Standards even if both the funding source and the nature of the compensation are disclosed.
C)
in violation of the Standards even if both the funding source and the nature of the compensation are disclosed.
According to Standard I(B) Independence and Objectivity, the member would be in violation because the nature of the compensation can be reasonably expected to influence the member’s independence and objectivity
Joanna Burgess, CFA, sends all of her investor clients a report which highlights industries the firm’s research department believes will outperform over the next year. She also includes her firm’s recommended list, which contains only the names of the 20 domestic stocks on which the firm has a buy recommendation. With respect to these actions, Burgess has:
A)
not violated the Standards of Practice.
B)
violated the Standards by not considering suitability for her clients who received the list.
C)
violated the Standards by not indicating the basic investment characteristics of the recommended stocks.
A)
not violated the Standards of Practice.
Brief communications are permitted (as brief as a list of recommended securities) as long as these recommendations are supported by appropriate background reports that can be made available to clients upon request. Sending a recommended list to all clients, even though not every recommended security is suitable for them, is not a violation of the Standards
A member or candidate who acquires non-material non-public information during the course of her work would most likely violate the Standards, with respect to this information, by:
A)
telling her husband.
B)
sharing it with her investment club.
C)
incorporating it in a research report.
A)
telling her husband.
Analysts may use non-material non-public information in writing a research report. Standard VI(B) Priority of Transactions specifically prohibits members and candidates from sharing non-public information, learned while performing their duties, with anyone who has an investment account for which the member is considered a beneficial owner.
Which of the following is most likely required of members and candidates by the CFA Institute Code of Ethics?
A)
Encourage others to practice in a professional manner.
B)
Judge the suitability of investments in the context of a client’s overall portfolio.
C)
Disclose to clients and prospects the basic principles of the firm’s investment processes.
A)
Encourage others to practice in a professional manner.
The Code of Ethics requires members and candidates to “practice and encourage others to practice in a professional and ethical manner.” The other choices are requirements of the Standards of Professional Conduct. Evaluating suitability in the context of a client’s total portfolio is required by Standard III(C) Suitability. Disclosing the basic characteristics of the investment processes is required by Standard V(B) Communication with Clients and Prospective Clients
Alan Powers, CFA, is a trader with Rogers Securities. His sister works for Potter Steel and has told him that Potter’s earnings, which will be released two days from now, are significantly less than expectations. Powers receives a buy order for the firm’s client accounts for a block of Potter shares. According to the Code and Standards, Powers’ most appropriate action is to:
A)
enter the trade without mentioning the coming earnings disappointment.
B)
ask his compliance officer to place Potter stock on the firm’s restricted list because he has material nonpublic information, to avoid making the trade.
C)
inform only the firm’s head of trading that the trade would not be in clients’ best interest, without disclosing the information.
A)
enter the trade without mentioning the coming earnings disappointment.
Standard II(A) Material Nonpublic Information requires members and candidates not to act or cause others to act based on material nonpublic information. As a general rule, if a member acts as he would if he did not possess the information, he will not violate this Standard.
One week after taking the Level II CFA exam, Mindy Hauser posts a message on a popular Web site: “I do not believe CFA Institute tested the curriculum fairly. I was ready to use the trick I learned for triangular arbitrage problems, and there weren’t any on the exam.” Does Hauser’s message violate the Standards related to conduct as a CFA candidate?
A)
No, because expressing an opinion is not a violation.
B)
Yes, because it compromises the reputation of the CFA Institute.
C)
Yes, because it compromises the integrity of the CFA examinations.
C)
Yes, because it compromises the integrity of the CFA examinations.
Standard VII(A) Conduct as Participants in CFA Institute Programs prohibits candidates from revealing information about the content of the CFA exams, including which topic areas or formulas were, or were not, tested on an exam.
The Standard concerning diligence and reasonable basis requires members to:
A)
include in a full research report all factors that can potentially have a negative effect on a recommended security.
B)
exercise independence and thoroughness in making investment recommendations or in taking investment actions.
C)
make a reasonable effort to ensure that investment performance is communicated fairly, accurately, and completely.
B)
exercise independence and thoroughness in making investment recommendations or in taking investment actions.
Standard V(A) Diligence and Reasonable Basis requires members and candidates to exercise diligence, independence, and thoroughness in making investment recommendations and taking investment actions. The Standard does not require all potentially negative future events to be included in a research report. Standard V(B) Communications With Clients and Prospective Clients requires analysts to use reasonable judgment in deciding which factors are important to their analysis, recommendations, and actions and to disclose these to clients and prospects. Ensuring that investment performance claims are fair, accurate, and complete is required by Standard III(D) Performance Presentation
Marshall Hopkins reports data for the Alliance Equity Fund. He states in an information sheet that “Alliance has produced a one-year return of 37%.” This result was based on Alliance’s best year in the past five. He discloses this in a footnote at the bottom of the information sheet. Hopkins’ action is:
A)
a violation of the Standard concerning performance presentation.
B)
a violation of the Standard concerning duties to clients and prospects.
C)
not a violation of the Code and Standards since he has disclosed the source of the 37% return number.
A)
a violation of the Standard concerning performance presentation.
The Code and Standards stipulate that members shall “make reasonable efforts to assure that performance information is a fair, accurate, and complete.” Since it is obvious that most investors would assume that 1-year performance data was for the previous year, his method of reporting is neither reasonable nor fair, and he is in violation of the Standard. The fact that he has indicated the basis of the presentation in a footnote does not place him in compliance with the Standard.
Which of the following statements regarding record retention is most accurate?
A)
The Standards require that records be retained for a minimum of seven years.
B)
While members are responsible for retaining research notes and other supporting documents, record retention is generally the responsibility of the firm.
C)
When a member changes employers, the member is responsible for transferring the records supporting his recommendations to his new employer.
B)
While members are responsible for retaining research notes and other supporting documents, record retention is generally the responsibility of the firm.
The firm is generally responsible for record-keeping as required by Standard V(C) Record Retention. Retaining records for at least seven years is not required by the Standard but is recommended if no other regulation applies. Records supporting investment actions and recommendations are the property of the firm. A member cannot take these records or copies of them to a new employer without permission from the original employer.
Bill Jackson, CFA, has established his own investment management firm. Jackson uses cost-benefit analysis to determine whether to vote proxies, and he informs his clients and prospects of this policy. Is Jackson in compliance with the Code and Standards?
A)
Yes.
B)
No, because he must also disclose the details of his cost-benefit analysis.
C)
No, because he has violated his duty of loyalty to clients by failing to vote some proxies.
A)
Yes.
According to Standard III(A) Loyalty, Prudence, and Care, if the costs of voting certain proxies exceed the benefits, the member or candidate can establish a policy to not vote all proxies. The member or candidate is required to inform clients of the proxy voting policy. Jackson has met these requirements and has not violated any Standards
Alvin Mell, CFA, is an investment advisor whose clients include Jack Allen, a famous professional athlete. Allen permits Mell to tell prospective clients that he is one of Mell’s clients. In a meeting with a new prospect, Mell truthfully states, “I was able to earn a 15% return for Jack Allen last year.” Mell has least likely violated the Standard concerning:
A)
performance presentation.
B)
misrepresentation.
C)
preservation of confidentiality.
B)
misrepresentation.
Mell did not misrepresent past performance or guarantee a future investment performance for the prospect, and thus did not violate Standard I(C) Misrepresentation. However, under Standard III(D) Performance Presentation, Mell’s statement is inadequate for representing reasonably expected performance. Even though Mell had Allen’s permission to tell prospects that Allen was a client, Mell violated Standard III(E) Preservation of Confidentiality by disclosing Allen’s financial details
With respect to members and candidates who are involved in distributing shares in oversubscribed initial public offerings (IPOs), the Code and Standards:
A)
require that these members and candidates not accept shares.
B)
recommend that these members and candidates not accept shares.
C)
only permit these members and candidates to accept shares if the firm has disclosed its allocation policies to clients.
A)
require that these members and candidates not accept shares.
Guidance for Standard III(B) Fair Dealing states that members and candidates who are involved in distributing oversubscribed IPOs may not withhold shares for themselves. Recommended procedures for compliance with Standard VI(B) Priority of Transactions suggest that members and candidates can avoid conflicts of interest with clients by not participating in IPOs.
Kapustin, Inc., increased its valuation allowance on certain deferred tax assets between 20X6 and 20X7. It also recognized a tax loss carryforward on its financial statements in 20X7; it did not recognize any in 20X6. What effects on Kapustin’s reported earnings in 20X7 will result from each of these two transactions?
Valuation allowance Tax loss carryforward
A)
Increase Decrease
B)
Decrease Increase
C)
Decrease Decrease
B)
Decrease Increase
The increased valuation allowance will result in an increase in deferred income tax expense and a decrease in Kapustin’s reported earnings for 20X7. The recognition of the tax loss carryforward will result in a decrease in income tax expense, a corresponding increase in a deferred tax asset, and an increase in Kapustin’s reported earnings for 20X7
Carolina Company has employee stock options outstanding for 100,000 shares that will be exercisable by the option holders in two years. The exercise price is $40 per share. The market price of Carolina shares was $42 on December 31 and averaged $38 during the year. When calculating its diluted earnings per share, Carolina should most likely:
A)
not include the options because they are antidilutive.
B)
not include the options because they cannot be exercised yet.
C)
include the options because they are potentially dilutive securities.
A)
not include the options because they are antidilutive.
Potentially dilutive securities are included in the diluted earnings per share (EPS) calculation only if their exercise would dilute (reduce earnings per share to less than) basic EPS. Because these options may only be exercised at $40 per share, and the average market price for the year is $38, the options are antidilutive and the diluted EPS calculation should not include them. Dilutive securities that are not immediately exercisable are included in the calculation of diluted EPS
The following set of data represents a sample from a normally distributed population of prices of jeans at a large retailer: $28, $36, $32, $30, $34, $32. Which of the following statements about this sample is least accurate?
A)
The range equals $8.
B)
The median equals $31.
C)
The mean absolute deviation equals 2.
B)
The median equals $31.
When we order the prices from least to greatest ($28, $30, $32, $32, $34, $36), we observe that the median is $32. (Tip: This is all that is needed to identify the inaccurate choice.) The range is $36 – $28 = $8. The mean is also $32, so the MAD = (|$28 – $32| + |$30 – $32| + |$32 – $32| + |$32 – $32| + |$34 – $32| + |$36 – $32|) / 6 = 2
The exchange rate yesterday between the U.S. dollar (USD) and Canadian dollar (CAD) was 0.85 USD/CAD. Today, the exchange rate closed at 0.89 USD/CAD. The U.S. dollar has:
A)
appreciated by 4.7%.
B)
depreciated by 4.7%.
C)
depreciated by 4.5%.
C)
depreciated by 4.5%.
Because it takes more U.S. dollars to buy a Canadian dollar today, the USD has depreciated. To determine the percentage depreciation of the USD, the USD must be the base currency (CAD/USD). Thus, the exchange rate yesterday is 1 / 0.85 = 1.1765 CAD/USD. The exchange rate today is 1 / 0.89 = 1.1236 CAD/USD. The percentage depreciation in the USD is 1.1236 / 1.1765 − 1 = −0.045, or −4.5%.
An analyst is examining inflation and changes in gold prices to determine if there is a significant linear relationship between the two. For a sample of 150 observations the correlation between the two variables is 0.1452. The critical values for the test statistic are ±1.65 at the 10% significance level and ±1.96 at the 5% significance level. For the null hypothesis that there is no correlation between the two variables, the analyst should:
A)
reject the null hypothesis at the 5% significance level.
B)
fail to reject the null hypothesis at the 10% significance level.
C)
reject the null hypothesis at the 10% significance level, but not at the 5% significance level.
C)
reject the null hypothesis at the 10% significance level, but not at the 5% significance level.
0.1452 - (150-2)’0.5 / 1 - 0.1452 ‘ 0.5 = 1.785
The researcher should reject the null hypothesis at the 10% significance value but not at the 5% significance level.
For a bond purchased by a company that intends to hold the bond to maturity, unrealized gains and losses in the bond’s value prior to maturity are most likely recognized:
A)
on the income statement.
B)
as a component of other comprehensive income.
C)
neither on the income statement nor in other comprehensive income.
C)
neither on the income statement nor in other comprehensive income.
Under U.S. GAAP, debt securities purchased with the intent to hold them until maturity are carried at amortized cost, not at fair value, so unrealized gains or losses are not reported on the income statement or as a component of other comprehensive income. Under IFRS, the standard treatment for debt securities purchased with the intent to hold them until maturity is measurement at amortized cost, but a firm may make an irrevocable choice at the time of purchase to carry any financial asset at fair value through profit and loss.
For the last year, the returns on stocks in an index were approximately normally distributed with a mean of 7% and variance of 0.04. There is a 95% probability that randomly selected portfolios of 20 of these index stocks will have mean returns for the last year between:
A)
0.8% and 14.8%.
B)
−1.8% and 15.8%.
C)
−0.4% and 14.4%.
B)
−1.8% and 15.8%.
The expected value of the sample mean will be 7%. The sample mean return will have variance equal to 0.04/20 = 0.002 or standard deviation =4.472%. Since the distribution of returns is approximately normal, a 95% confidence interval on sample mean return is 0.07 ± 1.96(0.04472), or −1.77% to 15.8%.
John Samson estimates the probability of selecting two red kings in two random draws from a standard deck of cards (52 cards, only two red kings) as (2/52)(1/51). This estimate is best described as a(n):
A)
a priori probability.
B)
empirical probability.
C)
Bernoulli probability.
A)
a priori probability.
This is an a priori probability because it is known in advance by reasoning, without performing any experiments or making any estimates. The probability of drawing both red kings in two draws is (2/52)(1/51) = 0.000754 or 0.07%.
A country’s monetary authority believes the long-term rate of real GDP growth is 3%. To achieve its target inflation rate of 2%, the central bank sets its policy rate at 4%. Current monetary policy in this country is best described as:
A)
neutral.
B)
expansionary.
C)
contractionary.
B)
expansionary.
To determine whether monetary policy is expansionary or contractionary, we compare the central bank’s policy rate to the neutral interest rate. The neutral interest rate is the sum of the real trend rate of GDP growth and the target inflation rate. Because the policy rate of 4% is less than the neutral interest rate (3% + 2% = 5%), monetary policy is expansionary.
Master Machines bought a customer list from a competitor leaving the market. The list has an estimated economic life of five years and no residual value, and it is recorded as an intangible asset. A year later, industry changes lead Master to reduce the list’s remaining useful life to two years. This change in the useful life will most likely result in:
A)
a decrease in net income in the next year and restatement of historical financial statements.
B)
higher amortization expense in the next year but no restatement of historical financial statements.
C)
a restatement of historical financial statements to reflect the change but no change in net income for the next year.
B)
higher amortization expense in the next year but no restatement of historical financial statements.
The customer list is a finite lived intangible asset, and the firm will amortize it each year. The change in the amortization period is a change in estimate, which is accounted for prospectively. Thus, the remaining (unamortized) intangible asset balance will be amortized over a 2-year period. If the useful life had not been changed, the remaining amortization period would have been four years, and the company would have had lower amortization expense. Thus, the change in estimated life increases the amortization expense. Restatement of past financial statements is not required for a change in accounting estimate. units-of-production method
Interest incurred by a company as part of constructing an asset over multiple accounting periods is least likely to be included on the income statement in:
A)
interest expense.
B)
cost of goods sold.
C)
depreciation expense.
A)
interest expense.
Interest expense incurred in the construction of an asset is capitalized. If the asset is for sale to a customer, the capitalized interest is included in inventory and subsequently expensed in cost of goods sold. If the asset is for internal use, interest is included in the value of the asset on the balance sheet and expensed through depreciation of the asset over time
Primary factors influencing the price elasticity of demand for a product are least likely to include:
A)
changes in consumer price expectations.
B)
the amount of time that has passed since the price change.
C)
the relative amount of consumer budgets spent on the product.
A)
changes in consumer price expectations.
Changes in consumer price expectations shift the aggregate demand curve to the right or left, but do not necessarily affect the price elasticity of demand for a product. The three primary factors influencing the price elasticity of demand for a product are the availability and closeness of substitute goods, the proportion of income spent on the product, and the time since the price change.
Volt Manufacturing reported a LIFO reserve of $82 million at the end of 20X1 and $75 million at the end of 20X2, and faced a tax rate of 34% for both years. The least appropriate adjustment to Volt’s 20X2 financial statements to make them comparable with an IFRS reporting company that uses the FIFO inventory cost method is to:
A)
decrease cash by $25.5 million.
B)
increase inventory by $75 million.
C)
increase operating profit by $7 million.
C)
increase operating profit by $7 million.
For 20X2, FIFO COGS would have been higher than LIFO COGS by $7 million, which would decrease operating profit by $7 million.
Purcell Co. has entered into a contract to build a parking ramp over a period of two years for $3.3 million. The contract specifies an additional payment of $300,000 if Purcell completes the project in 18 months. In reporting its revenue over the life of the project, should Purcell include the additional payment in the transaction price?
A)
Purcell is required to do so.
B)
Only if Purcell actually completes the project in 18 months.
C)
Only if it is highly probable Purcell will complete the project in 18 months.
C)
Only if it is highly probable Purcell will complete the project in 18 months.
A variable payment should be included in the transaction price of a project only if it is highly probable that the project can meet the conditions for the payment.
Compared to using the LIFO method, during periods of rising prices, a company that uses the FIFO method will most likely have a higher:
A)
inventory turnover ratio.
B)
total asset turnover ratio.
C)
interest coverage ratio.
C)
interest coverage ratio.
The interest coverage ratio will be higher under FIFO because cost of goods sold is lower, resulting in higher earnings before interest and taxes. Inventory turnover will be lower because a company using FIFO will have lower cost of goods sold and higher inventory compared to the LIFO method. Total asset turnover will be lower using FIFO because higher inventory will result in higher total assets
Aries Industries reports under IFRS and owns a warehouse that it rents to a construction company. Aries has the option to report this asset using either:
A)
the cost model or the revaluation model.
B)
the cost model or the fair value model.
C)
the cost model, the revaluation model, or the fair value model.
B)
the cost model or the fair value model.
Under IFRS, a warehouse owned primarily to earn rental income is classified as investment property. A firm may choose the cost model or the fair value model for reporting investment property
It is most likely that the aggregate demand curve slopes downward because at higher domestic price levels:
A)
net exports decrease.
B)
consumers increase their nominal cash balances.
C)
consumers experience a decrease in nominal wealth.
A)
net exports decrease.
Without a change in the exchange rate, higher prices for domestic goods will decrease exports and thereby decrease aggregate demand. An increase in the price level decreases real wealth, not nominal wealth. While consumers would like to hold more cash with increased prices, without a change in the money supply, as a group, they cannot and interest rates will rise to a new equilibrium level
A researcher constructs a hypothesis test to determine whether the abnormal returns to an investment strategy are positive. Using 60 months of data, he has found the average monthly abnormal returns for the strategy to be 1.1% with a standard deviation of 4.75%. Based on these results, the researcher would reject the null hypothesis at:
A)
both a 5% and a 2.5% significance level.
B)
neither a 5% nor a 2.5% significance level.
C)
a 5% significance level but not a 2.5% significance level.
C)
a 5% significance level but not a 2.5% significance level.
The null hypothesis is that mean abnormal monthly returns are less than or equal to zero, and the alternative is that monthly abnormal returns are greater than zero. This is a one-tail test and the sample size is large, so the critical value is 1.645 for a 5% significance level or 1.96 for a 2.5% significance level. The test statistic is:
0.011/0.0475/60’0.5 = 1.79
The researcher would reject the null hypothesis at the 5% level of significance but not at the 2.5% significance level.
An analyst prepared the following selected horizontal common-size balance sheet data for Spider Corporation:
Year 20X5 20X6 20X7
Current assets 113.6 106.1 101.4
Current liabilities 130.7 128.9 131.0
In the base year, Spider’s current ratio was 1.5. Spider’s current ratio as of December 31, 20X7, is closest to:
A)
0.77.
B)
1.16.
C)
1.29.
B)
1.16.
Because 20X7 current assets were 1.014 times base year current assets and 20X7 current liabilities were 1.31 times base year current liabilities, the 20X7 current ratio is (1.014 / 1.31)(1.5) = 1.161. (
Which of the following statements best describes the flexibility afforded in the cash flow statement classification of interest paid and dividends received (from investments) under IFRS?
Interest paid Dividends received
A)
CFO or CFF CFO or CFI
B)
CFO or CFI CFO or CFI
C)
CFO or CFI CFO or CFF
A)
CFO or CFF CFO or CFI
IFRS allows interest paid to be reported as either CFO or CFF, and dividends received to be classified as either CFO or CFI
Other things equal, which of the following economic changes is most likely to be associated with an increased trade deficit?
A)
Increased domestic investment.
B)
Decreased government spending.
C)
Increased savings by domestic consumers.
A)
Increased domestic investment.
The relationship among the trade balance (X − M), domestic private savings (S), domestic private investment (I), and the fiscal balance [tax receipts (T) − government spending (G)] is stated as X − M = (S − I) + (T − G). Holding the other factors constant, an increased trade deficit (X – M becomes more negative) may be associated with decreased S, increased I, decreased T, or increased G
An analyst wants to test the hypothesis that the mean monthly returns are equal on the stocks of two major oil companies, over the last 60 months, assuming that the returns are approximately normal and that the variance of monthly returns is equal for the two stocks. He would most appropriately calculate a test statistic using:
A)
the difference between the mean monthly returns of the two stocks and the pooled variance of the returns on the two stocks.
B)
the average of the differences between the monthly returns on the two stocks and the standard deviation of the differences.
C)
the difference between the mean monthly returns of the two stocks and the individual variances of returns for the two stocks.
B)
the average of the differences between the monthly returns on the two stocks and the standard deviation of the differences.
The returns on the stocks of two major oil companies are very unlikely to be independent, as both will respond in a similar way to changes common risk factors, such as oil prices and expectations of economic growth. When the two samples are not independent, a paired comparisons test is the most appropriate. The test statistic is the mean difference divided by the standard error of the mean difference.
For which of the following types of investment companies are shares least likely to trade at their net asset value?
A)
Venture capital fund.
B)
Exchange-traded fund.
C)
Open-end mutual fund.
A)
Venture capital fund.
A venture capital fund will have a limited number of investors who commit funds, and the venture capital fund’s manager invests these monies in start-up companies. The venture capital fund does not trade itself, and it is highly illiquid. Any transactions in the fund by its investors are likely to occur at a discount or premium, depending on the fund’s success to date.
Due to its redemption procedures, an exchange-traded fund (ETF) will track the fund’s net asset value, but it can sell at a small premium or discount to its net asset value. Open-end mutual funds trade at their net asset values per share. New shares are issued at a price equal to this net asset value at the time of the investment
Starlight, Inc., has a degree of operating leverage of 1.2 and degree of financial leverage of 1.8. Starlight’s earnings last year were $1 million on sales of $20 million. If sales increase to $23 million, Starlight’s estimated earnings based on these measures of leverage will be closest to:
A)
$1,216,000.
B)
$1,324,000.
C)
$1,454,000.
B)
$1,324,000.
Degree of total leverage = 1.2 × 1.8 = 2.16
Percent change in sales = $23 / $20 − 1 = 15%
Percent change in earnings = 15% × 2.16 = 32.4%
Expected earnings = $1 million × 1.324 = $1,324,000
Which of the following would most appropriately be termed an absolute risk objective? Return should be:
A)
5% or more each year with a 95% probability.
B)
greater than or equal to the risk-free rate.
C)
above the return on the S&P 500 index with a 90% probability.
A)
5% or more each year with a 95% probability.
Returns of 5% or more 95% of the time is an absolute return objective. The other objectives are stated relative to the risk-free rate and relative to the S&P 500 index.
The following cost and price information are given for a company:
Variable cost per unit $7.00
Fixed financing cost $12,000
Fixed operating cost $9,000
Operating breakeven quantity 3,000 units
If the company sells 5,000 units, net income is closest to:
A)
$0.
B)
−$6,000.
C)
−$12,000.
B)
−$6,000.
Operating breakeven quantity = fixed operating cost / (price − variable cost per unit)
3,000 = $9,000 / (price − $7)
price = ($9,000 / 3,000) + $7 = $10
Net income at 5,000 units = 5,000($10.00 − $7.00) − $9,000 − $12,000 = −$6,000
The following cost and price information are given for a company:
Variable cost per unit $7.00
Fixed financing cost $12,000
Fixed operating cost $9,000
Operating breakeven quantity 3,000 units
If the company sells 5,000 units, net income is closest to:
A)
$0.
B)
−$6,000.
C)
−$12,000.
B)
−$6,000.
Operating breakeven quantity = fixed operating cost / (price − variable cost per unit)
3,000 = $9,000 / (price − $7)
price = ($9,000 / 3,000) + $7 = $10
Net income at 5,000 units = 5,000($10.00 − $7.00) − $9,000 − $12,000 = −$6,000
James Franklin, CFA, has high risk tolerance and seeks high returns. Based on capital market theory, Franklin would most appropriately hold:
A)
a high-risk biotech stock.
B)
a high-beta portfolio of risky assets.
C)
a leveraged position in the market portfolio.
C)
a leveraged position in the market portfolio.
According to capital market theory, all investors will choose a combination of the market portfolio and borrowing or lending at the risk-free rate; that is, a portfolio on the CML. An investor with high risk tolerance will choose a position in the market portfolio, partially funded by borrowing at the risk-free rate.
Over a recent period, an investment portfolio had a positive M-squared alpha but its Jensen’s alpha was negative. A portfolio manager should conclude that the portfolio:
A)
had a Sharpe ratio less than that of the market portfolio.
B)
returned more than its equilibrium expected return based on its systematic risk.
C)
lies on a capital allocation line that has a slope greater than that of the capital market line.
C)
lies on a capital allocation line that has a slope greater than that of the capital market line.
If a portfolio’s M-squared alpha is positive, its Sharpe ratio, which equals the slope of the portfolio’s capital allocation line, is greater than that of the market portfolio. Negative alpha means the portfolio returned less than its expected equilibrium return based on its systematic risk
A company’s management is most likely increasing shareholders’ wealth if the company’s:
A)
average book value of total capital is increasing over time.
B)
return on invested capital is greater than its weighted average cost of capital.
C)
market capitalization increases by the sum of the net present values of its completed projects.
B)
return on invested capital is greater than its weighted average cost of capital.
If a company’s return on invested capital is greater than its weighted average cost of capital, the company’s management is increasing the value of the firm and shareholders’ wealth. Book value of total capital may increase (e.g., by additional borrowing) even if management is not creating value for shareholders. Changes in a company’s stock value (and therefore its market capitalization) are a function of expectations about the profitability of its future investments.
Taking a private company public in the United States and at the same time raising capital for company growth would be best achieved through:
A)
an IPO.
B)
a SPAC.
C)
a direct listing.
A)
an IPO.
In an IPO (initial public offering), typically shares are sold to raise equity for the company. With a SPAC (special acquisition company), a company is purchase by the SPAC. With a direct listing, existing shares are traded on an exchange but no additional shares are issued to raise capital
At what stage of a company’s life cycle is it most likely to have the highest proportion of debt in its capital structure?
A)
During its growth stage.
B)
Early in its mature stage.
C)
Late in its mature stage.
B)
Early in its mature stage.
Companies typically have the highest proportion of debt during the mature stage of their life cycle, when their cash flows are high and stable and debt financing is available at a low cost. Later in their mature stage, as their equity values increase, companies tend to have lower proportions of debt in their capital structures, and they may deleverage by repurchasing debt.
In conducting an industry analysis for a firm, an analyst would most likely put a higher valuation on a company, all other things equal, if the industry’s:
A)
capacity utilization is low.
B)
Herfindahl-Hirschman index is low.
C)
market shares have been stable.
C)
market shares have been stable.
Stable market shares indicate a low degree of competition among industry rivals, which is consistent with higher profits and valuation. Low HHI or low capacity utilization are indications of a high degree of competition among industry firms, which decreases profitability and value relative to a high HHI or capacity utilization.
A synthetic short position in a common stock can be created by combining a:
A)
long put position, a long T-bill position, and a short call position.
B)
short put position, a long T-bill position, and a long call position.
C)
long put position, a short T-bill position, and a short call position.
C)
long put position, a short T-bill position, and a short call position.
The put-call parity condition is stock price − present value of exercise price = call price − put price, or −stock price = put price − PV of exercise price − call price. Remember that a negative sign indicates a short position and a positive sign indicates a long position. That means we can rewrite this equation as follows:
short stock position = long put position + short T-bill position + short call position
Which of the following is least likely an identified market pricing anomaly?
A)
Average equity returns during the month of January are higher than returns in any other month.
B)
Purchasing shares of an initial public offering when they first start trading produces positive risk-adjusted, long-term returns on average.
C)
Shares of firms that have reported positive earnings surprises have had positive abnormal returns on average over the period after the earnings announcement.
B)
Purchasing shares of an initial public offering when they first start trading produces positive risk-adjusted, long-term returns on average.
Shares purchased in the open market when IPO shares begin trading have actually underperformed in the long run on a risk-adjusted basis, not outperformed. The January and earnings surprise effects are among the market anomalies that have been identified.
For an investment in a private capital partnership, management fees are most likely calculated as a percentage of the:
A)
total amount of investor funds committed to the partnership at its inception.
B)
amount of investor funds that have actually been invested in portfolio companies.
C)
total (market or model) value of the portfolio companies held in the portfolio at year-end.
A)
total amount of investor funds committed to the partnership at its inception.
For private capital partnerships, management fees are based on the total amount of committed capital, even prior to its investment in portfolio companies
The category of alternative investments most likely to produce current income as well as the potential for appreciation in value is:
A)
timberland.
B)
commodities.
C)
infrastructure.
A)
timberland.
Timberland can earn income from the harvest and sale of trees and can also increase in value over time. Investments in commodities may provide price appreciation but typically do not produce income. While brownfield (constructed) infrastructure investments may produce current income, greenfield (to be constructed) infrastructure investments do not provide income until they are built and put into service.
Scott Malooly recently purchased a $100,000 face value, semi-annual coupon bond from a dealer that quoted a price of 105.19. He received an invoice for $107,390. The most likely explanation is that the difference represents:
A)
interest that Malooly owed at settlement.
B)
the commission on the trade.
C)
the change in bond price between the purchase date and the settlement date.
A)
interest that Malooly owed at settlement.
When a bond trades between two consecutive coupon dates, the seller is entitled to receive interest earned from the previous coupon date until the date of the sale. The price paid includes accrued interest and is referred to as the full price. The quoted price is the flat price, which does not include accrued interest.
An investor bought a 3% option-free 12-year bond at a yield to maturity of 4.6% on a semiannual bond basis. If she sells this bond after seven years for 91.41, she will realize:
A)
a capital loss.
B)
a capital gain.
C)
neither a capital gain nor capital loss.
A)
a capital loss.
Calculate the constant-yield value of the bond at the end of seven years as:
N = 10; I/Y = 4.6 / 2 = 2.3; PMT = 3 / 2 = 1.5; FV = 100; CPT PV = −92.925, which is the carrying value of the bond at the time of sale. The sale price per 100 of par value is less than the carrying value by 92.925 − 91.41 = 1.515, which is the capital loss over the seven-year holding period.
The yield spread on a 5-year corporate bond is most likely to widen as a result of a(n):
A)
increase in the bond’s credit rating.
B)
decrease in market liquidity for the bond
C)
decrease in the 5-year government note yield.
B)
decrease in market liquidity for the bond.
Spread risk includes credit migration (downgrade) risk and market liquidity risk. A corporate bond’s spread to its benchmark is likely to widen if its credit rating is downgraded or its market liquidity decreases. Other things equal, a change in yield for the benchmark bond should not affect the yield spread.
When pricing European options with a binomial model, the expected payoff at expiration is discounted at an interest rate that:
A)
does not include a risk premium.
B)
depends on investor preferences.
C)
reflects the probabilities of up-moves and down-moves.
A)
does not include a risk premium.
Because binomial pricing models use the concepts of replication and risk neutrality, the expected payoff is discounted at the risk-free rate.
Hal Peterson, CFA, is calculating an enterprise value for Shepherd Company. Peterson should most appropriately sum the market values of the firm’s outstanding debt and equity:
A)
without adjustment.
B)
and subtract the value of its cash and short-term investments.
C)
and subtract the value of its goodwill and other intangible assets.
B)
and subtract the value of its cash and short-term investments.
Enterprise value = market value of equity + market value of debt − cash and short-term investments.
A private equity firm considering a public company as a leveraged buyout candidate would be least likely to find which of the following target-firm characteristics attractive?
A)
Strong profit growth.
B)
Inefficient operations.
C)
Predictable cash flow.
A)
Strong profit growth.
Strong profit growth is not necessarily an attractive feature for private equity investment because the price of a firm with growing profits likely reflects expectations of good future profit growth. In an LBO, a private equity firm seeks through its own efforts to increase the value of the target firm significantly. When a target firm’s operations are inefficient, value can likely be increased by better management and perhaps replacement of key people. Predictable cash flow is a plus because the cash can service the added debt created in an LBO transaction
For securities backed by residential mortgages, the structure that is most likely to provide credit enhancement is:
A)
sequential-pay tranches.
B)
PAC and support tranches.
C)
senior and subordinated tranches.
C)
senior and subordinated tranches.
Credit enhancements, such as a senior/subordinated structure, reapportion the default risk of a mortgage-backed security. A sequential-pay structure or a planned amortization class (PAC) tranche combined with one or more support tranches reapportion the prepayment risk of a mortgage-backed security.
Other things equal, an increase in the cash flows from an underlying asset during the life of a forward contract would result in a forward contract with a:
A)
lower price at initiation.
B)
lower value at initiation.
C)
higher price at initiation.
A)
lower price at initiation.
Higher cash flows reduce the net cost of carry and reduce the forward price, other things equal.
Bill Guillen invests $10 million in a fund-of-funds that allocates 30% to hedge fund X, 30% to hedge fund Y, and 40% to hedge fund Z. The fund-of-funds has a fee structure of 1 and 10, with the management fee calculated on the amount of the initial investment and incentive fees calculated independently of management fees. Returns after fees for the three hedge funds over the year are as follows: fund X = 14%, fund Y = –8%, and fund Z = 22%. Guillen’s return on his investment in the fund-of-funds is closest to:
A)
8.5%.
B)
9.6%.
C)
10.6%.
A)
8.5%.
The returns on the investment before any fund-of-funds fees are as follows:
0.3(14%) + 0.3(–8%) + 0.4(22%) = 10.6%
Management fee = 1%
Incentive fee = 0.10(10.6%) = 1.06%
After-fee return on fund-of-funds investment = 10.6% – 1% – 1.06% = 8.54%
A secondary securities market in which liquidity is provided by those seeking to trade is most appropriately referred to as:
A)
a quote-driven market.
B)
an order-driven market.
C)
an over-the-counter market.
B)
an order-driven market.
Liquidity is provided by other traders in an order driven market where buy and sell orders are matched according to order matching rules and pricing rules. In a quote-driven or over-the-counter market, liquidity is provided by dealers in the specific security.
Which of the following statements is most accurate regarding the stages of venture capital investment?
A)
Angel investors are more likely to be individuals than venture capital funds.
B)
Mezzanine-stage financing refers to debt with the option to convert to equity.
C)
Later stage financing typically occurs as the company is preparing for its IPO.
A)
Angel investors are more likely to be individuals than venture capital funds.
The angel stage is the first block of funding in the formative stage, usually before a venture capital fund has become involved. Later stage financing is used for expansion, before mezzanine-stage financing, which is so called because it is raised to prepare the firm for IPO, not because it is convertible debt.
An investor notes that the price for a futures contract on an asset is less than the price for an otherwise identical forward contract on the asset. It is most likely that interest rates are expected to be:
A)
constant.
B)
positively correlated with the price of the underlying asset.
C)
negatively correlated with the price of the underlying asset.
C)
negatively correlated with the price of the underlying asset.
When interest rates are negatively correlated with the price of the underlying asset, the mark-to-market cash flows on the futures contract will require cash when interest rates are higher and provide cash when interest rates are lower.
A bond that is trading at 101.3 has an effective duration of 16.4 and an effective convexity of −168. An estimate of the percentage price decrease in this bond as a result of a positive parallel shift in the yield curve of 30 basis points is closest to:
A)
4.9%.
B)
5.0%.
C)
5.1%.
B)
5.0%.
The approximate percentage change in the bond’s price is estimated as:
−16.4(0.003) + 0.5(−168)(0.003)2 = −0.049956 = −4.9956%.
A floating rate note with three years to maturity is valued at 101.34 percent of par. For this bond it is most likely that the:
A)
required margin is less than the quoted margin.
B)
required margin is less than the discount margin.
C)
reference margin is less than the discount margin.
A)
required margin is less than the quoted margin.
The required margin is the percentage discount rate that would make the bond price equal to its par value. The quoted margin is the percentage (of par) that the bond will pay. Because this bond is trading at a premium, the required margin must be less than the quoted margin
In the industry life cycle model, an industry that is experiencing slow growth in sales, high prices, and a high percentage of failing businesses is most likely to be in the:
A)
decline stage.
B)
shakeout stage.
C)
embryonic stage.
C)
embryonic stage.
In the embryonic stage, industry growth is slow because consumers are unfamiliar with the product, prices are high because firms have not yet achieved economies of scale, and the competitors tend to be start-up firms that have a high probability of failing. In the shakeout stage, prices tend to be low due to intense price competition. In the decline stage, industry sales are decreasing.
The repo margin in a repurchase agreement refers to the:
A)
annualized percentage return to the lender of funds.
B)
difference between the purchase price and market price of the underlying bond.
C)
difference between the purchase price and the repurchase price of the underlying bond.
B)
difference between the purchase price and market price of the underlying bond.
The repo margin is the difference between the amount the lender of funds (buyer of the underlying bond) pays for it and its market price or value. This margin offers protection to the repo lender if the value of the bond decreases over the term of the repo agreement.
Hope Company has grown from a small-capitalization firm to a mid-capitalization firm. In which type of equity index is Hope most likely to be added or removed as a result?
A)
Style index.
B)
Sector index.
C)
Multi-market index.
A)
Style index.
Indexes of small-cap or mid-cap stocks are classified as style indexes. Sector indexes are defined based on industry sectors. Multi-market indexes refer to those that include stocks from more than one country.
A decrease in the risk-free interest rate will have what effects on the values of a call option and a put option?
Value of a call option Value of a put option
A)
Decrease Increase
B)
Increase Increase
C)
Increase Decrease
A)
Decrease Increase
A decrease in the risk-free rate will decrease the value of a call option and increase the value of a put option.
A potential problem with both the Sharpe and Sortino ratios as measures of risk-adjusted performance is that:
A)
negative outcomes may be extreme.
B)
returns distributions may have positive skewness.
C)
correlations of returns with other investments are not considered.
C)
correlations of returns with other investments are not considered.
Neither the Sharpe ratio nor the Sortino ratio considers diversification benefits from less-than-perfect correlations of portfolio returns with returns on other investments. Positive skew may not affect the Sortino ratio because it is based only on downside returns deviations. The Sortino ratio does adjust for the effects of extreme negative outcomes
The price of an interest rate swap is equal to:
A)
zero at initiation.
B)
its par swap rate.
C)
its value to the fixed-rate payer.
B)
its par swap rate.
The par swap rate, or fixed rate specified in the contract, is the price of an interest rate swap.
The price of an interest rate swap is equal to:
A)
zero at initiation.
B)
its par swap rate.
C)
its value to the fixed-rate payer.
B)
its par swap rate.
The par swap rate, or fixed rate specified in the contract, is the price of an interest rate swap.
A par bond yield curve is constructed from the yields of:
A)
hypothetical bonds.
B)
government bonds trading at par.
C)
corporate bonds trading at or near face value.
A)
hypothetical bonds.
The par yield curve is constructed from the yields of hypothetical bonds at different maturities that would be trading at par given current spot rates
The yield spread for a single-A rated corporate bond will most likely be affected by:
A)
the bond’s liquidity.
B)
the bond’s maturity.
C)
the expected inflation rate.
A)
the bond’s liquidity.
The yield spread for a bond is the sum of its credit risk premium and a liquidity premium.
